Gorman Financial Management, LLC

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Taming Investment Taxes

The Tax Cuts and Jobs Act lowered the marginal tax rates that apply to ordinary income, such as wages and interest from bonds and savings accounts, for 2018 through 2025. Fortunately for investors, capital gains and qualified dividends still receive preferential tax treatment.

Although your investing strategy should be based primarily on your financial goals, time horizon, and risk tolerance, it's important to pay attention to the tax implications of your investment decisions. This may be more complicated than it first appears. For example, income from investments held in taxable accounts could push more of your overall income into a higher marginal tax bracket or beyond a threshold that would trigger taxes on Social Security benefits and higher Medicare premiums.

Here are several strategies that could help reduce your overall tax burden.

Capital Gains and Dividends

Stocks sold for a profit may be subject to the capital gains tax. Long-term capital gains are profits on investments held for more than 12 months. Qualified dividends (from stocks held for at least 61 days within a specified 121-day period) are subject to the same tax rates as long-term capital gains. Nonqualified dividends and short-term capital gains are taxed as ordinary income.

High-income taxpayers may also be subject to a 3.8% net investment income tax on capital gains, dividends, interest, royalties, rents, and passive income if their modified adjusted gross income (AGI) exceeds specific thresholds ($200,000 for single filers or $250,000 for joint filers).

Strategy: If you have realized net capital gains from selling stocks for a profit, you might avoid taxes on some or all of your gains by selling losing positions by the end of the year. Any losses over and above the amount of your gains can be used to offset up to $3,000 of ordinary income ($1,500 if married filing separately) or carried forward to reduce your taxes in future years.

Mutual Fund Distributions

Mutual funds are required to distribute realized capital gains and any interest or dividend income to shareholders on an annual basis. When mutual funds are held in taxable accounts, shareholders must pay taxes on these distributions (as long-term or short-term capital gains, dividends, or interest) for the year in which they are received, even if the distribution is reinvested in new shares.

On the specified distribution date, each investor receives a payment equal to the per-share distribution amount multiplied by the number of shares he or she owns, and the fund's share price (or net asset value) is reduced by the per-share distribution amount.

Strategy: Before purchasing mutual fund shares, you should check the timing and amount of upcoming distributions (typically in December) to potentially avoid taxes on gains you didn't participate in.

Portfolio Placement

Consider the tax efficiency of the various types of investments in your portfolio. For example, some mutual funds turn over securities more frequently and can run up larger tax bills than funds with less turnover. Fixed-income investments that generate interest, and short-term capital gains triggered by more frequent trading, are taxed as ordinary income at higher rates.

Strategy: Hold investments that are less tax efficient in a tax-deferred account whenever possible.

The return and principal value of stock and mutual fund shares fluctuate with changes in market conditions. When sold, shares may be worth more or less than their original cost. Before you take any specific action, you should consult with your tax professional.

Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

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